Question

You are tasked with estimating the cost of capital for a firm. The risk-free rate is 1.9%, the expected rate of return on the market is 14.9%. Now, another similar company (similar unlevered cost of capital) has a debt-to-equity ratio of 1 to 3 . It has a debt beta near zero and an equity market-beta of 1.4. Your own firm has more debt, for a debt-to-equity ratio of 1 to 1 , with a debt beta of 0.2 . What is a good estimate for your equity cost of capital?

Answer 1

To estimate the equity cost of capital for your firm, you need to consider the risk-free rate, the expected rate of return on the market, and the company's debt-to-equity ratio. The estimate for your equity cost of capital is 21.4%.

Step-by-step explanation:

To estimate the equity cost of capital for your firm, you need to consider the risk-free rate, the expected rate of return on the market, and the company's debt-to-equity ratio. The risk-free rate is 1.9% and the expected rate of return on the market is 14.9%. Another similar company with a debt-to-equity ratio of 1 to 3 has a debt beta near zero and an equity market-beta of 1.4.

Your firm has a debt-to-equity ratio of 1 to 1 and a debt beta of 0.2. To estimate your equity cost of capital, you can use the formula:
Equity Cost of Capital = Risk-Free Rate + (Equity Market-Beta * (Expected Rate of Return on the Market - Risk-Free Rate))

Therefore, the estimate for your equity cost of capital is:
Equity Cost of Capital = 1.9% + (1.4 * (14.9% - 1.9%)) = 21.4%